In 2015 alone, taxes on tobacco products raised more than €110 billion for EU governments.

Tobacco smuggling and sales of illegal tobacco products threaten this income and society at large. Sales of illegal products mean that governments and citizens lose out on tax revenue, which instead flows into the hands of criminals who also traffic drugs and guns into Europe. Proceeds from the sale of illegal tobacco may also be used to fund terrorism. The fight against illegally traded tobacco is therefore a fight to protect EU citizens.

Authorities state that, from a health perspective, consumers are put at risk when they consume counterfeit tobacco products. These products are not held to EU quality standards and are passed off as legitimate products in Europe. As these illegal products are not subject to the same rigorous scrutiny as legal tobacco products, authorities assert that consumers cannot be sure of what they contain.

Fine-cut tobacco plays a vital role in reducing the risk of counterfeit products and securing government tax revenues. High unemployment and falling wages over the last ten years, combined with steady increases in tobacco taxation, have significantly reduced price-sensitive consumers’ ability to afford legal tobacco products. While rising cigarette prices force consumers to seek out cheaper products, consumers who can no longer afford cigarettes find in fine-cut tobacco a legal and affordable alternative to illegally traded cigarettes. Fine-cut tobacco therefore acts as a buffer between legal and illegal products, due largely to its lower price.

Most of ESTA’s members are mid-sized or small, often family-owned, operations. Many ESTA members operate in rural and economically disadvantaged areas where employment opportunities are scarce. Their activities contribute to the local economy and society. Poorly conceived taxes on tobacco can have disproportionate effects on smaller manufacturers, driving them out of the market, thereby further increasing market concentration. A well-balanced tobacco tax policy should take into account local industries by addressing the differences between smaller and large producers.

Excise Duties

An excise duty is a tax applied to certain goods at the moment of manufacturing, rather than at the time of sale. Maintaining different excise tax levels for different tobacco products is necessary to reflect varying levels of consumer price sensitivity, manufacturer profiles, and modes of production for different products.

As a semi-finished product, fine-cut tobacco is a different consumer good compared to cigarettes. Smokers must make separate purchases of rolling paper, or tubes, before investing time to manually prepare fine-cut smoking articles for use. This aspect gives fine-cut tobacco a lower tax-bearing capacity compared to finished-product cigarettes, a fact that has been recognised by both Member States and the European Commission.

Consumers of fine-cut tobacco are also predominantly more price sensitive than consumers of cigarettes. A rise in taxes on cigarettes and fine-cut tobacco will result in a higher proportion of fine-cut tobacco smokers looking for cheaper alternatives, which tend to be illegal tobacco products. A uniform tax on tobacco products is, therefore, counterproductive in combating illegal trade.

The manufacturing of fine-cut tobacco also differs from that for cigarettes, further adding to the disparity in tax-bearing capacity. The fine-cut tobacco manufacturing process is relatively labour intensive compared to cigarettes. Manufacturers of fine-cut tobacco are often small and mid-sized enterprises, many of which are family owned and located in rural and economically disadvantaged areas where they are important employers. A uniform tax that is sustainable for large multinationals would disproportionately and unfairly penalise smaller producers and their consumers.

For all of these reasons, it is important to maintain an excise tax differential between fine-cut tobacco and factory-made cigarettes.

Member States’ Prerogative

Taxation is a national competency in the EU, with Member States having the individual freedom to set their own levels of taxation. There are very good economic reasons for keeping this ability at the level of Member States. Different national markets have different structures and consumer profiles. For example, applying the same tax on beef in both Germany and Latvia could unfairly distort the market in the latter because Latvian consumers will likely have a different relative demand for beef and will differ in their ability to afford the potentially higher German rate.

The same is true of tobacco products. A uniform excise duty would not work in all markets. It would result in the erosion of tax revenues for some national governments and fuel illegal trade. A sustainable tax rate in one market may push trade onto the black market in another. Taxes on tobacco products must be sensitive to the differences between national markets and the specificities of each market.

National governments are best placed to address the particular circumstances of their markets in their tax codes. Some Member States, for example, rely more on tax revenue from tobacco than others. These countries should be able to design their respective tax codes accordingly. The same holds for health policies and priorities, which differ between Member States and are best handled by national governments.

Revision of “Excise Directive” 2011/64/EU

The Council Directive 2011/64/EU on the structure and rates of excise duty applied to manufactured tobacco, also referred to as the Excise Directive, has been very successful in its aim of raising excise requirements while also allowing Member States flexibility in implementing the Directive. There is no evidence that a further reform of the Directive would make it more effective.

The last review of the Directive resulted in an increase in the minimum excise requirements for fine-cut tobacco from 40% of the weighted average retail selling price (€40 per kg) in 2010 to 50% of the weighted average retail selling price (€60 per kg) in 2020. The structure of the Directive allows national governments to increase this minimum gradually over ten years and to set tax rates while taking account of national issues, such as the tax charged in neighbouring countries, illegal trade and smoking tobacco traditions.

This structure is sensible and has been clearly communicated to all stakeholders. No internal market, fiscal, legal or Treaty justifications exist to amend the Directive once again. In order to avoid disruption to the EU internal market and to maintain legal clarity, the current minimum excise rate target for 2020 should be respected.

Taxation and Illegal Trade

Maintaining a price differential between lower-priced fine-cut tobacco and cigarettes has an essential role in combating illegal tobacco smuggling. Standard economic logic dictates that demand for tobacco does not fluctuate greatly in response to changes in price. While it is true that demand for tobacco is, per se, highly inelastic, the demand for duty-paid tobacco is more sensitive to a change in price. In the absence of a cheaper legal option, price-sensitive consumers faced with more expensive cigarettes will turn to the illegal market to find a cheaper alternative. Due to its nature as a cheaper, legal alternative to cigarettes, fine-cut tobacco fulfils a vital buffer function between legal cigarettes and illegal products. Price-sensitive consumers turning away from expensive cigarettes and looking for more affordable options can purchase fine-cut tobacco, instead of switching to the illegal products.

For many European governments, the public health objective of tobacco regulation is to decrease the prevalence of smoking by making tobacco products less affordable. However, that objective is not achieved when lower income consumers shift their tobacco purchases from a legal to illegal market. There is, therefore, a fine balance to strike taking into account the public health objective and varying income levels of individual consumer groups. As reported by a UK non-profit study, low-income consumers unable to afford legal tobacco are as much as twice as likely to buy illegal products. Two further studies by the UK government and a UK public health network have placed the rate of switching to illegal products at 66% to 75%, respectively.

Recent developments underscore the importance of the buffer function of fine-cut tobacco in excise policy. During the economic crisis, fine-cut tobacco sales volumes grew at an average annual rate of 5.1% between 2009 and 2012. As the economic situation across Europe stabilised, fine-cut tobacco sales declined by 2.5% between 2013 and 2015. Cigarette volumes grew by just over 1% during the same period, according to a European Commission study, and the illegal trade in cigarettes in the EU remained more or less stable, ranging between 9% and 11%. This illustrates the fact that fine-cut tobacco can act as an alternative to illegal tobacco products for price-sensitive consumers turning away from legal cigarettes.

The updated London Economics study published in 2018 reinforces the point that affordability is a key driver amongst fine-cut tobacco smokers. It underscores that they can and do switch to the illegal market in the face of price hikes. The UK serves as a prime example of this substitution relationship.

In 1993, the UK adopted a tobacco tax ‘escalator’ policy to raise excise duties on tobacco products. In 2001, the escalator policy was halted and taxes on tobacco products were frozen. This taxation slowdown continued (essentially unchanged) until 2010 when the escalator policy was re-introduced. Given the high and increasing duties on fine-cut tobacco, the UK experienced some of the most significant levels of illegal trade in fine-cut tobacco in Europe (as high as 62% of total consumption in 2004-05).

Ultimately, increased enforcement activities, combined with lower increases of the duties imposed on fine-cut tobacco, resulted in a reduction in the level of illegal trade to its lowest recorded level of 35% of consumption in 2011-12. Government revenue from fine-cut tobacco taxation also rose from £200m in 2000-01 to £1.1bn in 2013-14. However, with the re- introduction of the tobacco taxation escalator in 2010, the trend in illegal trade has reversed, increasing to 39% of consumption in 2013-14. The associated tax loss rose by £1 billion over the same period. This is a clear example of why the buffer function of fine-cut tobacco is crucial to protecting tax revenues and preventing price-sensitive consumers from switching to the illegal tobacco products.

Taxation and Customs

When it comes to customs and taxation, the EU has different tobacco product categories. Aligning these definitions would be counterproductive, as it would increase confusion and administrative burdens for businesses and would undo the progress that has been made in modernising the legislation in these areas.

On the customs side, the Combined Nomenclature is the set of definitions based on the World Customs Organization’s ‘harmonised system’ nomenclature, with additional subdivisions. If the harmonised system nomenclature changes, then the Combined Nomenclature has to be updated in turn.

For taxation, tobacco product categories are defined in the Directive on the structure and rates of excise duty applied to manufactured tobacco (2011/64/EU), also known as the Excise Directive.

The Combined Nomenclature and Excise Directive have been developed for very different purposes. The Combined Nomenclature, which covers all tobacco products from the raw material to the finished products, seeks to harmonise classification, statistics and the declaration of products in international trade, as well as protect the European Single Market by enabling precise targeting of customs tariffs or quotas.

The Excise Directive, on the other hand, has been developed to harmonise excise treatment of manufactured tobacco products within the EU by providing common definitions, tax structure requirements (for cigarettes) and EU-wide minimum excise rates.

A majority of Member States have advised, based on their experience with the two systems of classification, that both are largely consistent with each other and that the costs and legal uncertainty are confined to niche products.

In addition, the 2015 Ramboll evaluation study on holding and movement of excise goods clearly shows that both authorities and economic operators are satisfied with the modernisation of what used to be one of the most burdensome pieces of EU legislation. Aligning the customs and excise tobacco product definitions would undermine the progress made so far and add greater administrative burden, especially for SMEs.

ESTA members manufacture fine‑cut tobacco, pipe tobacco, traditional European nasal snuff and chewing tobaccos in 10 Member States and export their products across the entire world. Skilled craftspeople expertly apply age old techniques, perfecting the mixture of dozens of varieties, tastes, smells and flavours, continuing a centuries‑old tradition of fine European heritage. Up to the end of the last century, the manufacture of tobacco in Europe encompassed hundreds of small producers creating thousands of signature products. Over the past 30 years, smaller firms have been acquired by larger multinational companies or have ceased activities altogether, leading to employment reductions and the disappearance of traditional brands. In the manufacturing countries, tobacco production is often rooted in less advantaged regions and plays locally a key economic and social role. It deserves protection and at the minimum should be considered when developing regulation.

Between 2008 and 2012, consumption of fine-cut tobacco in the EU28 increased by 37%, even though the increase varies heavily per Member State. Because of the severe economic crisis, consumer disposable income was under pressure, impacting the growth of fine-cut tobacco consumption. This increase demonstrates the price sensitivity of fine-cut tobacco smokers.

As the economic crisis subsided between 2012 and 2015, fine-cut tobacco consumption declined in the EU and the market adjusted, returning to its pre-crisis normal order.

In 2016, sales of fine-cut tobacco kept declining by 1.09% in the EU28. This long=term downward trend follows to an extent industry consolidation.

Seemingly out of step, several eastern countries still experience percentage increases in fine-cut tobacco sales whilst starting at very low sales levels. This demonstrates the buffer function of fine-cut tobacco: cigarette consumers who can no longer afford this product find in fine-cut tobacco a legal alternative to illegal cigarettes that are often smuggled from neighbouring countries outside the EU (see London Economics Study, June 2015).

Sometimes fine-cut tobacco is mistakenly presented as a “hook” to smoking because of its relatively higher affordability when compared to cigarettes.

The reality of the market shows a very different picture. In most European countries, fine-cut tobacco was and still is a niche tobacco product enjoyed by “specialist” consumers and traditional tobacco enthusiasts who enjoy fine European craftsmanship.

Few exceptions exist with high market shares in countries where fine-cut tobacco has a long history and forms part of the cultural heritage. In these specialised tobacco markets, the significance of fine-cut tobacco stems from its century-old local manufacturing.

Every year, taxes on tobacco products raise more than €100 billion for EU governments. Tobacco tax policy must be delicately balanced to safeguard government revenues, protect fair competition, jobs and public health, whilst also deterring trade in illegal tobacco. Tobacco smuggling and sales of illegal tobacco products threaten this income and society at large. The fight against illegally traded tobacco is part of a wider effort to protect EU citizens.

A successful implementation of Track & Trace will be of crucial importance, and requires workable standards that fit business and trading practices, making them likely to be internationally shared.

The EU is characterised by a very diverse and flexible excise structure, which allows each Member State to set a balanced taxation of tobacco products respecting its national circumstances, interests and objectives. Last year, excise revenues from smoking tobacco increased across the EU, even though sales declined. This clearly demonstrates the efficiency of the current flexibility left to national governments and that a “one size fits all” approach should not be considered. The few Member States (e.g. France, Netherlands) casting economic theory and the tax-bearing capacity of smoking tobacco aside had adverse effects with declining revenues whilst sales increased.

An obvious correlation exists between the highest levels of illegal and non-­domestic consumption (e.g. France, UK, Ireland, Poland and Finland) and the highest taxation rates applied to fine-cut toconsbacco, in comparison with cigarettes. The figures clearly show that any alignment of tobacco taxation, regardless of the products’ specificities, will prevent fine-cut tobacco from fulfilling its buffer function, leading to increased illegal trade of cigarettes and driving down government revenues.